Don’t downgrade the rating agencies, downgrade the regulators.

Sir, already a couple of years into this crisis Philip Stephen shows a surprising lack of understanding of it, in his “Downgrade the rating agencies”, January 20. 

Suppose that human fallible credit rating agencies were able to produce absolutely perfect ratings, in terms of measuring the risk of default, and which are of course used by the banks to choose who to lend to, how much, and at what rate. 

But consider the fact that regulators imposed capital requirements for banks that were also based on the same ratings, and which functioned therefore like a hallucinogen, a veritable LSD; increasing the banker’s sensitivity to risk, so that he perceived a good ratings in a much brighter light, and a not so good ratings took on an even scarier appearance. 

As should have been expected by any independent regulator, not part of a incestuous group-think, the consequences were: 

A growing excessive bank exposures to what is officially perceived ex-ante as not risky, like the triple-A rated securities and infallible sovereigns, leading to a dangerous overcrowding of the safe-havens and; 

A growing bank underexposure to what is officially perceived as risky, like in lending to small businesses and entrepreneurs, equally dangerous, because of the lost opportunities to create the next generation of jobs for our grandchildren. 

So again it was not primarily the rating-message’s fault it was the fault of those who ordered how those rating-messages were to be read. Downgrade those regulators! 

Occupy Basel! http://bit.ly/dFRiMs